A Chinese Lesson for Western Economists

Income inequality has been rising in China, prompting some to suggest that the nation’s market-oriented policies must be curbed. The official government newspaper, The People’s Daily, disagrees in a July 20 article, “The Limitation of the Gini Coefficient in China.”

The Gini coefficient is widely used in international economics to measure income inequality in nations. Economist Wei Jie, Director of the National Center for Economic Research at Tsinghua University, notes that the Gini coefficient tends to indicate higher levels of inequality in nations that have not completed the urbanization process. In China, large income differences are to be expected because much of the population (60 per cent) lives in lower-income rural areas. Generally, in First World economies, 30 per cent or fewer of the inhabitants live in rural areas. Further, Wei Jie points out that income inequality as measured by the Gini coefficient may worsen as incomes at the lowest levels are increasing — at the same time as the poor are getting richer! Professor Wei Jie offers a valuable lesson for Western and international economics.

These are important points, and the latter is especially relevant to discussions in the Western world where the conventional politics-of-envy discussion of income equality leads to the untenable conclusion that it would be better for everyone to be poorer than for some to be richer. This is evident in the frequently cited claim that the “rich get richer” and the “poor get poorer.” This is half true. The rich have gotten richer. However, the poor are also getting richer. From 1971 to 2001, U.S. Census Bureau data indicate that the average income of the least affluent quintile (20 per cent) of U.S. households rose 26 per cent (adjusted for inflation).

Progress has been so substantial that a report by the Swedish Research Institute of Trade found African-American median income to the overall Swedish median (average Swedish income is approximately the same as the Western European average). It is thus true that the rich have gained more than the poor have. However, the principal point is that all, including the poor, have gained.

There is often a tendency to think of poverty in relative terms, such as the income of the lowest-income quintile compared with the highest. However, this is a mistake. If people define poverty as having an income in the bottom 10 per cent, then poverty will not be eradicated.

Relative poverty indicators are inappropriate and rooted in envy. What is important is not how much money low-income households have in relation to rich households but whether they have enough to live a comfortable life. Thus, for example, the United States defines poverty in terms of a standard of living and not in terms of envy. (Of course, it would be desirable for all households to prosper to the same extent as the most affluent.)

Despite considerable attempts under socialist, mixed, and free market economies, income equality has not been achieved. No economic system has been identified that can substantially reduce income inequality without reducing the incomes of the lowest-income households. That is why policies that improve the absolute incomes of low-income households are preferable to envy-based relative measures. Joseph Schumpeter expressed the purpose of a free market economic system with respect to income distribution thusly: The capitalist achievement does not typically consist in providing more silk stockings for queens, but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.

High-income nations have different policies that seek to improve incomes among the least affluent. Western European nations tend to have larger social welfare systems and higher rates of long-term unemployment, which they accept in return for less economic growth and affluence. In the United States, the policy priority is employment and economic growth. Most people in Western Europe and the United States live well. Further, low-income households in Western Europe and the United States live better than does the average household in most middle-income and virtually all low-income nations. The most reliable road to greater affluence for all, including low-income households, is strong economic growth. Harvard’s Benjamin Friedman suggests in a recent book that economic growth is more than desirable — it is also necessary for longer-term social cohesion.

International and Western economic analysis would do well to end its unhealthy affection for the politics of envy.